Dor Alon Energy In Israel (1988) (TLV:DRAL) Use Of Debt Could Be Considered Risky

Legendary fund manager Li Lu (who Charlie Munger backed) once said, 'The biggest investment risk is not the volatility of prices, but whether you will suffer a permanent loss of capital.' So it might be obvious that you need to consider debt, when you think about how risky any given stock is, because too much debt can sink a company. We can see that Dor Alon Energy In Israel (1988) Ltd (TLV:DRAL) does use debt in its business. But the real question is whether this debt is making the company risky.

When Is Debt Dangerous?

Generally speaking, debt only becomes a real problem when a company can't easily pay it off, either by raising capital or with its own cash flow. In the worst case scenario, a company can go bankrupt if it cannot pay its creditors. While that is not too common, we often do see indebted companies permanently diluting shareholders because lenders force them to raise capital at a distressed price. By replacing dilution, though, debt can be an extremely good tool for businesses that need capital to invest in growth at high rates of return. The first step when considering a company's debt levels is to consider its cash and debt together.

View our latest analysis for Dor Alon Energy In Israel (1988)

What Is Dor Alon Energy In Israel (1988)'s Net Debt?

As you can see below, at the end of September 2020, Dor Alon Energy In Israel (1988) had ₪2.04b of debt, up from ₪1.93b a year ago. Click the image for more detail. However, because it has a cash reserve of ₪418.4m, its net debt is less, at about ₪1.62b.

How Strong Is Dor Alon Energy In Israel (1988)'s Balance Sheet?

According to the last reported balance sheet, Dor Alon Energy In Israel (1988) had liabilities of ₪1.39b due within 12 months, and liabilities of ₪2.56b due beyond 12 months. On the other hand, it had cash of ₪418.4m and ₪559.9m worth of receivables due within a year. So it has liabilities totalling ₪2.97b more than its cash and near-term receivables, combined.

The deficiency here weighs heavily on the ₪1.26b company itself, as if a child were struggling under the weight of an enormous back-pack full of books, his sports gear, and a trumpet. So we definitely think shareholders need to watch this one closely. At the end of the day, Dor Alon Energy In Israel (1988) would probably need a major re-capitalization if its creditors were to demand repayment.

In order to size up a company's debt relative to its earnings, we calculate its net debt divided by its earnings before interest, tax, depreciation, and amortization (EBITDA) and its earnings before interest and tax (EBIT) divided by its interest expense (its interest cover). The advantage of this approach is that we take into account both the absolute quantum of debt (with net debt to EBITDA) and the actual interest expenses associated with that debt (with its interest cover ratio).

Dor Alon Energy In Israel (1988) shareholders face the double whammy of a high net debt to EBITDA ratio (6.6), and fairly weak interest coverage, since EBIT is just 1.3 times the interest expense. The debt burden here is substantial. Notably, Dor Alon Energy In Israel (1988)'s EBIT was pretty flat over the last year, which isn't ideal given the debt load. When analysing debt levels, the balance sheet is the obvious place to start. But you can't view debt in total isolation; since Dor Alon Energy In Israel (1988) will need earnings to service that debt. So when considering debt, it's definitely worth looking at the earnings trend. Click here for an interactive snapshot.

Finally, a business needs free cash flow to pay off debt; accounting profits just don't cut it. So it's worth checking how much of that EBIT is backed by free cash flow. Looking at the most recent three years, Dor Alon Energy In Israel (1988) recorded free cash flow of 40% of its EBIT, which is weaker than we'd expect. That's not great, when it comes to paying down debt.

Our View

On the face of it, Dor Alon Energy In Israel (1988)'s interest cover left us tentative about the stock, and its level of total liabilities was no more enticing than the one empty restaurant on the busiest night of the year. Having said that, its ability to grow its EBIT isn't such a worry. After considering the datapoints discussed, we think Dor Alon Energy In Israel (1988) has too much debt. While some investors love that sort of risky play, it's certainly not our cup of tea. There's no doubt that we learn most about debt from the balance sheet. However, not all investment risk resides within the balance sheet - far from it. Consider for instance, the ever-present spectre of investment risk. We've identified 3 warning signs with Dor Alon Energy In Israel (1988) (at least 1 which can't be ignored) , and understanding them should be part of your investment process.

If you're interested in investing in businesses that can grow profits without the burden of debt, then check out this free list of growing businesses that have net cash on the balance sheet.

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